Monday, May 23, 2011

Silver Offers Options Profits for the Savvy

It’s a silver world and we’re just living in it. Just last week, the spot price of silver was around $50 and investors were flocking to this precious metal in droves. This week, reality set in and silver sold down to the mid-$30s. Still, silver has caught the interest of opzions trading  investors, whether they are categorized as retail, day traders, market makers or something else again.
While institutional investors typically use futures contracts to gain exposure to silver, individual investors have a bevy of exchange traded funds to choose from. The one that has grabbed the most attention is the iShares Silver Trust (NYSE: SLV). Before April, SLV experienced average daily volume around 35 million shares, a pretty impressive number. Then volume exploded and over the course of April there were seven trading sessions with volume north of 89 million shares. On three of those days the volume trading was more than 150 million. If the Trading Gods held a popularity contest SLV would undoubtedly be crowned the victor.
In simple terms the SLV attempts to track silver prices. Those wishing to dive into the details of how the SLV is structured can check out the iShares Silver Trust page.
Unlike some of the other commodity ETFs plagued by contango issues — like the United States Oil Fund (NYSE: USO) – SLV does a pretty good job accomplishing its objective. It is an effective vehicle for the masses to gain exposure to silver prices without having to deal with the higher margin, leverage, and volatility issues inherent to silver futures contracts.
In addition, the vast majority of retail traders in SLV are not subject to the futures margin requirements that were implemented this week. Many analysts have said these tightened margins were a factor in the decline of silver futures.
Not only has SLV seen a huge rise in volume, volatility has also been on the move. One of the simpler indicators used by traders to measure the realized volatility of a stock is the Average True Range (ATR). Over the past month we’ve seen the ATR on SLV rise from $.90 to more than $2.00. Part of this rise comes from the fact that SLV is trading at higher prices, but part also comes from the expansion of SLV’s intraday range. This increasing volatility attracts day traders as volume and volatility are what day traders thrive on. These are the traders that shun a stock if it doesn’t provide adequate liquidity or price movement. And since SLV has been providing ample quantities of both you can bet your bottom dollar it’s currently a popular spot for these intraday players.
(Source:  MachTrader)
The volume surge has also occurred in the options traded on SLV, as seen in the graphic below. As a result of this increased speculative activity we’ve seen quite the rise in implied volatility (the gold line in the graphic) over the same time period. Given the elevated status of implied volatility traders desiring to enter the silver frenzy should consider using option selling strategies. Here are two ideas:
SLV Option Trades
The key to playing extended volatile names like SLV is using defined risk trades and position sizing properly. By doing so you will be able to stomach the volatile ride that this shiny metal may have in store. There has been quite a sell off in silver and some traders may be tempted to just buy calls believing a bounce upward is due. But with an underlying this volatile, other trading strategies make more sense.
Covered Calls — Traders owning shares of SLV willing to limit their profit potential may consider selling out-of-the-money covered calls. Since options on SLV are listed with strike prices in $1 increments traders have a variety of options to choose from. Which strike price a trader sells ultimately depends on their outlook on SLV and the desired amount of protection. Since implied volatility has risen to lofty levels, covered call sellers are able to capture more premium than normal.
Bull Call or Bull Put Spreads — The elevated implied volatility is also a reason why bullish traders should think twice about running out and purchasing call options on SLV. If volatility does fall from these lofty levels option buyers will face an uphill battle in making a profit. As an alternative consider entering a bull call or bull put spread. These trades, also known as vertical spreads, increase your probability of profit as well as lessen your exposure to an adverse move in volatility.
A typical bull call spread involves the simultaneous purchase of a call of one strike price and the sale of a call with the same expiration month at a higher strike price. Both are opening transactions and are of the same number of contracts. These spreads are considered moderately bullish which may be a good fit for the highly volatile SLV. Since sellers have come to the fore in this ETF a dramatic upward move may just not be in the cards right now.
I hesitate to offer specific strikes for these trades due to the moves that SLV has been making in the last week. Check the option chains on SLV before making any trade. The huge voulme of trading in SLV offers investors the opportunity to quickly open and close positions.
At the time of this writing Tyler Craig had no positions in SLV.

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